Fed raises key rate and unveils plan to reduce bond holdings

WASHINGTON — The Federal Reserve has raised its benchmark interest rate for the third time in six months, providing its latest vote of confidence in a slow-growing but durable economy. The Fed also announced plans to start gradually paring its bond holdings later this year, which could cause long-term rates to rise.

The increase in the short-term rate by a quarter-point to a still-low range of 1 percent to 1.25 percent could lead to higher borrowing costs for consumers and businesses and slightly better returns for savers.

The central bank chose to raise rates again despite an economic slowdown at the start of 2017, which it predicts will prove temporary. It foresees one additional rate hike this year, unchanged from its previous forecast. It gave no hint of when that might occur.

The latest Fed rate hike, announced in a statement after a policy meeting, comes as the U.S. economy is growing only sluggishly. Even so, many of the barometers the Fed monitors most closely have given it the confidence to keep gradually lifting still-low borrowing rates toward their historic norms.

Though it assesses the overall economy, the Fed’s mandates are to maximize employment and stabilize prices. And hiring in the United States remains solid if slowing, with employment at a 16-year-low of 4.3 percent — even below the level that the Fed associates with full employment.

Inflation has been more problematic, having long stayed below the central bank’s 2 percent target rate. Recent data have suggested that inflation may even be slowing further. But Fed officials have said they think inflation will soon pick up along with the economy.

That said, no one expects the Fed’s rate hikes to turn aggressive. If nothing else, the chronically low inflation and the political fights and uncertainty in Washington — over investigations into Russia’s ties to President Donald Trump’s campaign, health care legislation, tax-cut plans and about whether Congress will raise the nation’s borrowing limit and pass a new budget — could lead the Fed to raise rates more slowly than it otherwise would.

Uncertainty also surrounds the membership of the Fed’s own policy committee. Trump is expected soon to fill three vacancies on the Fed’s influential board, and those new members, depending on who they are, could alter its rate-setting policy.

Fed officials have concluded that the economy, now entering its ninth year of expansion, no longer needs the ultra-low borrowing rates they supplied beginning in the Great Recession.

The central bank kept its benchmark rate at a record low near zero starting in late 2008 to try to boost consumer and business borrowing and lift the country out of the worst downturn since the 1930s. It finally raised the rate modestly in December 2015, then waited a year do so again. It acted again in March.

At the depths of the recession, the Fed began buying Treasury and mortgage bonds to try to depress long-term loan rates. That effort resulted in a five-fold increase in its portfolio to $4.5 trillion. The Fed said Wednesday that it would eventually allow a small amount of bonds to mature without being replaced — an amount that would gradually rise as markets adjusted to the process.

Some news reports have mentioned leading candidates to fill the three vacancies on the Fed’s seven-member board. They include Randal Quarles, a top Treasury official in two past Republican administrations, for the vice chairman’s job of overseeing bank regulation. Marvin Goodfriend, an economist at Carnegie Mellon University, has been mentioned for another board spot, and Robert Jones, chief executive of Old National Bancorp in Indiana, reportedly is a candidate for a board seat designated for a community banker.

The betting is that the administration will choose officials who will tilt the Fed toward a more “hawkish” stance. Hawks tend to worry that rates kept too low for too long could escalate inflation or fuel asset bubbles. By contrast, “doves” favor the direction taken under Chair Janet Yellen, favoring relatively low rates to maximize employment.

Yellen, the first woman to lead the Fed, is serving a term that will end in February. So far, Trump has sent conflicting signals about whether he plans to nominate her for a second term.